You already know the state of the markets. You know, too, how clients feel watching assets dwindle. Industry experts tell you that a down market is the best time to acquire new clients and new assets under management, but you know this may not be the best time for every investment vehicle.
Take variable annuities, for example. The VA industry has had it tough. The National Association for Variable Annuities (NAVA) reports net premium flows for VAs down 18.8% in the second quarter compared to 2Q in 2001; they also declined from 1Q 2002. Deborah Tucker, VP of communications at NAVA, points out that while the amount in equities as an investment objective component of VAs at the end of 2001 was 58.5% and dropped to 54.5% at the end of June, the amount in fixed accounts, bonds, and money market subaccounts all rose (see table on page 89). This seems to indicate, says Tucker, that rather than change their allocations in existing contracts, people are buying new products.
Everything Old Is New Again
The trend is definitely toward security and guarantees. Tucker mentions it, as does Laurie Lewis, chief counsel, federal taxes, at the American Council of Life Insurers (ACLI), a trade organization. It's not so much a trend, says Lewis, as an appreciation of features often there all along; ignored in the bull market, they've taken on a higher profile. Increased interest in VAs with fixed-rate funds is up, says Lewis. Fixed-rate funds guarantee a certain percentage of return, and a fixed sum of money every month.
Other familiar features are death benefits and minimum income guarantees. "When there's no down market," says Lewis, "people don't pay any attention." When the market fluctuates, it's different. Most annuities, she points out, guaranteed your heirs at least a return of premium if you died before taking payments; other annuities might return premiums plus 1% to 2% a year. "When [variable] annuities were returning 15% or 20% a year," she adds, no one noticed. They also ignored minimum income benefits. "This is a pessimistic industry," says Lewis, reminding us that in constructing its products, the insurance industry considers the Biblical "seven fat years and the seven lean years."
A Sure Thing
With this concentration on hard-times provisions, companies are reacting to consumer interest in security, on everyone's mind in these very insecure days. One way, says NAVA's Tucker, is to shift the focus of annuities as growth or accumulation vehicles to annuities as guaranteed retirement income.
Being able to annuitize "and not outlive your assets" is popular, says Tucker. Since "most people figure they will never be able to retire" due to market erosion of their assets, she adds, investors will value annuities that enable them to "cover fixed obligations" such as a mortgage or utility bills. Another feature in product development that consumers find important, she says, is the ability to liquidate. Investors want the ability to take money out of their VAs; some riders being added to contracts include that right.
Among new products and options in the VA market are Lincoln Financial Group's Income4Life Solution, The Hartford's Principal First, and American Skandia's Guaranteed Maturity Annuity. Each allows withdrawal of principal in one form or another, catering to people's fear of tying up their money for long periods of time or even indefinitely.
The irony is that consumers are also preoccupied about guaranteeing an income stream amount, even though few people ever convert their annuities into an income stream. In fact, according to Lorry J. Stensrud, CEO of Lincoln Retirement and executive VP of Lincoln National Life Insurance Company, only 1% of annuity holders currently annuitize. If holders keep control of their assets, they feel better, Stensrud says, and that is what Income4Life offers by allowing them to withdraw money--even after annuitization. The monthly payout will drop, of course, but having the option is popular, Stensrud claims. Despite being "launched in one of the worst equity markets we've ever had," notes Stensrud, the product was well received--perhaps more in anticipation than in actual purchase, since he says, "for every dollar [of the Income4Life Solution] we sell, we probably sell three or four dollars [of annuities] where [advisors] say, 'I like the feature [Income4Life] but don't need it now and may need it in a few years.'"
The Hartford's product offers a guarantee that investors "will never get back less than the amount they invested" in a VA contract as long as withdrawals in any year are limited to 7% of the total amount invested. Ryan Johnson, VP of sales and marketing at The Hartford, points out that in the last few years there's been new interest in "living benefits" that allow annuity holders to lock in returns or guarantee a minimum income. The Hartford, he says, "did not participate . . . until the last couple of years. We did not feel comfortable with the way a lot of those provisions were structured, and took a completely different look" at changing its VA products. The result was Principal First, a "guaranteed minimum account benefit through structured withdrawal." Principal First, in addition to limiting withdrawal to 7%, also allows a lock-in of gains in a good market. (There may, of course, be an additional charge for this latter benefit, says the literature.)
Times Are Tough All Over
The American Skandia product announced September 16, a single premium modified guaranteed annuity, comes amid much speculation about what parent Skandia plans for its American subsidiary. Costs of Skandia's U.S. expansion were so high that it is now exploring possibilities to cut those losses. Possibilities mentioned are sale or merger of its American subsidiary to another company, according to published reports in The New York Times and the Wall Street Journal; Patricia Abram, senior VP and chief marketing officer at American Skandia, had no comment.
Advisors should also know about H. R. 3320, called the Lifetime Annuity Payout Act, introduced last November. The bill, introduced by Reps. Phil English (R-PA), Karen Thurman (D-FL), and Nancy Johnson (R-CT), seeks to extend the capital gains tax rate to annuity payments received by annuitants and their survivors. It is appropriate, says Lewis, because of pension changes over the years "from the defined benefit world," she explains, when you would "work for 30 years and get a pension, and now you work for 10 years here and five years there and there is no guarantee. Annuity writers are looking for a way to provide that guarantee." More information is available at www.retiresmarter.net/, a site sponsored by ACLI.
Not So Fast
VAs are not popular with everyone. John Henry McDonald, of Austin Asset Management in Austin, Texas, says that if an investor put 60% of assets into a no-load S&P 500 index fund and 40% into a vehicle that mimics the Lehman Brothers Bond Index, "and withdrew 4.65% from that pile of assets, there's a 95% chance it'll last for the rest of your natural life; that's the Monte Carlo simulation." VAs, he says, offer a 4% withdrawal but charge 190 basis points, or thereabouts, for the privilege.
"If you took the 60/40, you'd take out capital gains. Your tax advantage would be better," says McDonald. Heirs would get the stepped-up basis, too. With VAs, however, while distribution of principal is not taxed, the interest on the principal is taxable, and as ordinary income rather than capital gains. Then there are those other charges to pay on top of the tax.
The regular investor doesn't discipline himself to set up a 60/40 portfolio and withdraw 4% per year, and pays a high price for it, says McDonald; insurance companies are "charging a lot of money for nothing." They also, he points out, have many different fees. Indeed, Income4Life Solution's fees run as follows: Mortality and expense charge, 1.15%; administrative fee, 0.10%; Income4Life Solution fee, 0.40%; 12-b1 fee, 0.25%; and fund fees and expenses (unspecified). There are also surrender charges, a 25-basis-point distribution fee for changing the access period (the time during which money may be withdrawn), and a contingent deferred sales charge (maximum 6%). "The consumer," says McDonald, "gives up control in exchange for a lot of fees."
Robert Fleener, communications consultant at Lincoln Retirement, responds, "With systematic withdrawal, there is no assurance of a lifetime income. By purchasing an annuity with Income4Life Solution, the investor has the assurance of lifetime income plus the ability to control assets, fund management, and withdrawals." He adds, "A variable annuity can offer income that has the potential to outpace inflation."
The Bottom Line
Clients often lack discipline. They also would often rather turn over managing their financial lives to someone else; in fact, that's why many have advisors. So it's frequently up to the advisor to decide if the trends in the VA industry are indeed beneficial to clients or have more of a "new lamps for old" feel to them. Security is something that many people will willingly pay for. You and your client will have to determine together if that's the case when it comes to VAs, and if so, whether the price is right.